The Reducing Balance Method (also called the Declining Balance Method) is one of the most widely used accelerated depreciation techniques across global accounting systems. Unlike the Straight-Line Method — which spreads asset costs evenly across years — the Reducing Balance Method applies a consistent depreciation rate to the asset’s diminishing book value. This naturally results in higher depreciation in the early years and lower depreciation in later years, providing a more realistic representation for assets that lose economic value rapidly.
This method is especially favored in industries where technology evolves quickly, where machinery experiences heavy early usage, or where initial economic benefits are substantially higher. It is recognized by both IFRS (IAS 16) and U.S. GAAP as an acceptable depreciation method when the asset’s consumption pattern supports it.
1. Understanding the Reducing Balance Method
Definition
The Reducing Balance Method calculates depreciation as a fixed percentage of the asset’s book value at the beginning of each accounting year. Since the book value decreases every year, the depreciation expense also reduces annually, creating an “accelerated” pattern.
Key Features:
- Accelerated Depreciation: Larger expenses recorded in the early years when assets are more productive or experience greater usage.
- Diminishing Charges: Depreciation declines as the asset ages and its economic usefulness decreases.
- Never Fully Depreciates to Zero: The book value approaches zero but theoretically never reaches it — except when forced to residual value.
- Realistic Asset Consumption: Particularly suitable for fast-obsolete and high-wear assets.
- Globally Accepted: Approved under IFRS (IAS 16), U.S. GAAP (ASC 360), and most tax systems.
2. Formula for the Reducing Balance Method
The general formula is:
Depreciation Expense = Book Value at Beginning of Year × Depreciation Rate
- Book Value: Historical cost minus accumulated depreciation.
- Depreciation Rate: A fixed percentage determined by policy, legislation, or asset class.
Choosing the Depreciation Rate
- Some businesses use double the straight-line rate (Double Declining Balance).
- Others rely on tax depreciation schedules (e.g., MACRS in the U.S.).
- Certain jurisdictions specify standard rates for vehicles, computers, industrial machinery, etc.
Example rates used globally:
- Computers: 25%–40%
- Vehicles: 20%–30%
- Industrial Machinery: 10%–25%
- Medical Equipment: 15%–20%
3. Example of the Reducing Balance Method
Scenario:
A company purchases a machine for $10,000. It applies a 20% reducing balance depreciation rate.
Depreciation Schedule:
| Year | Book Value at Start ($) | Depreciation (20%) ($) | Accumulated Depreciation ($) | Book Value at End ($) |
|---|---|---|---|---|
| 1 | 10,000 | 2,000 | 2,000 | 8,000 |
| 2 | 8,000 | 1,600 | 3,600 | 6,400 |
| 3 | 6,400 | 1,280 | 4,880 | 5,120 |
| 4 | 5,120 | 1,024 | 5,904 | 4,096 |
| 5 | 4,096 | 819 | 6,723 | 3,277 |
This table illustrates a key feature of this method: the asset depreciates rapidly in the first few years and gradually slows down.
4. Journal Entry for Reducing Balance Depreciation
Regardless of the depreciation method, the journal entry remains the same:
Journal Entry:
Debit: Depreciation Expense
Credit: Accumulated Depreciation
Example (Year 1):
Debit: Depreciation Expense $2,000
Credit: Accumulated Depreciation $2,000
5. Differences Between Reducing Balance and Straight-Line Methods
| Aspect | Reducing Balance Method | Straight-Line Method |
|---|---|---|
| Depreciation Pattern | Higher depreciation initially; decreases annually. | A constant depreciation amount each year. |
| Calculation Basis | Book value at the beginning of each year. | Original cost minus residual value. |
| Best For | Assets with rapid early obsolescence (vehicles, electronics). | Assets with stable usage (buildings, office furniture). |
| Impact on Profit | Lower profits in early years. | Even profit impact throughout. |
| Tax Treatment | Often preferred for tax savings in early years. | Less advantageous for front-loaded tax deductions. |
6. Adjusting the Reducing Balance Method for Partial-Year Depreciation
When an asset is acquired in the middle of an accounting year, the first year’s depreciation must be prorated. This reflects the actual period of usage.
Example:
- Asset: Vehicle
- Cost: $30,000
- Purchased on: July 1st
- Rate: 25%
Full-Year Depreciation:
$30,000 × 25% = $7,500
Partial-Year Depreciation (6 months):
($7,500 × 6) ÷ 12 = $3,750
Journal Entry:
Debit: Depreciation Expense $3,750
Credit: Accumulated Depreciation $3,750
7. The IFRS & GAAP Perspective on the Reducing Balance Method
IFRS (IAS 16):
IAS 16 requires companies to depreciate assets in a manner that reflects their pattern of economic consumption. If an asset provides greater benefits in its early years, accelerated depreciation methods such as the Reducing Balance Method are appropriate.
U.S. GAAP (ASC 360):
GAAP also allows the Reducing Balance Method, especially when an asset is used more intensively in its early years. Additionally, U.S. tax law supports accelerated depreciation through systems like MACRS, which essentially follows reducing-balance logic.
8. Real-World Applications Across Industries
A. Technology & Electronics
Laptops, servers, and technology equipment lose value rapidly due to innovation cycles. Many companies apply a 30%–40% reducing balance rate to reflect their short technological life.
B. Manufacturing & Heavy Machinery
Machines experience intense usage early on. Accelerated depreciation helps manufacturers match expenses with production cycles and gain early tax advantages.
C. Transportation & Logistics
Vehicles such as trucks, vans, and delivery equipment depreciate quickly in value due to high mileage and wear-and-tear. A reducing balance method better reflects this reality.
D. Retail Industry
POS systems, refrigeration units, and security systems often become outdated quickly, making the reducing balance method a strategic choice.
9. Advantages of the Reducing Balance Method
- Reflects Real Asset Consumption: Better matches expenses to revenue in industries where assets lose value rapidly.
- Tax Savings in Early Years: Higher initial depreciation lowers taxable income.
- Supports Better Cash Flow: Early tax reductions support reinvestment.
- Favored in Fast-Paced Industries: Particularly in technology, logistics, and manufacturing.
10. Disadvantages of the Reducing Balance Method
- More Complex Calculations: Requires recalculation every year.
- Does Not Fully Depreciate Asset: The book value approaches zero but never reaches it unless forced to residual value.
- Front-Loaded Expenses: Lower profits in early years may not align with all business models.
When Should a Business Use the Reducing Balance Method?
The Reducing Balance Method is ideal when:
- The asset experiences rapid early wear or obsolescence.
- The company seeks tax advantages through accelerated depreciation.
- The asset’s productivity is highest in its first few years.
- The business wants depreciation to reflect the economic reality of asset usage.
Looking Beyond the Numbers: Strategic Value of Accelerated Depreciation
Depreciation is more than an accounting formality — it is a strategic tool. The Reducing Balance Method helps businesses align expenses with asset performance, manage taxable income, strengthen early cash flow, and support capital investment cycles. By understanding the deeper financial logic behind accelerated depreciation, companies can optimize their reporting outcomes and long-term financial strategies.
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